The threat that Israel will attack Iran's nuclear facilities has sent shudders through an already fragile crude market, and has raised fears that geopolitics could potentially wreak economic havoc.

Israel has let it be known that it believes Iran's nuclear program is approaching a “ point of no return” beyond which it would be impossible to prevent it from developing nuclear weapons.

Despite political analysts forecasting that US President Barack Obama will press Israeli Prime Minister Benjamin Netanyahu to defer action to allow time for sanctions to take effect, there has been a strong push in Israel for military action.

Adding to political and financial market woes, and creating uncertainty regarding the stability of the world's richest oil region, is the news that Saudi Arabia has indicated that it will seek nuclear capability if Iran achieves it.

In February, the European Union (EU) reached an agreement to sanction oil imports from Iran and freeze the assets of Iran's Central Bank within the EU. EU foreign policy chief Catherine Ashton commented that the sanctions are aimed at pressuring Iran to return to talks over its nuclear program.

Rumors rock the market

The investor community was dealt a harsh lesson on the volatility of crude prices as Iranian speculation, coupled with market rumors, resulted in an unanticipated surge in prices.

“The jump in price was prompted by an Iranian media report of an oil pipeline explosion in Saudi Arabia,” said Commerzbank analyst Carsten Fritsch. "Even if the original story came from Iran and no doubt was spread deliberately, the market clearly believes there to be an increased risk of supply shortfalls," he added.

Despite finger pointing at Iranian news sources as the reason behind recent volatility, the situation has highlighted the market's inability to absorb supply shocks - even headlines about supply shocks - in a market hindered by limited spare capacity.

Iran urges caution

The Iranian oil ministry has downplayed the effects of sanctions, and said such embargoes will only harm European economies and oil-consuming countries.

"The hasty decision by EU states to use oil as a political tool will have a negative impact on the world economy and especially on recovering European economies which are fighting to overcome the global financial crisis," it added.

Further contributing to an already tense market was the announcement by Iranian leaders that they could potentially close the Strait of Hormuz - a key transit route for global oil supplies - if increased western sanctions halt Iranian oil exports. The strait is the seaway through which the oil of Saudi Arabia, Iraq, Kuwait, Iran, and the United Arab Emirates is currently shipped.

Despite the attention focused on ever-growing tensions in Iran, analysts are casting attention on Ras Tanura, a peninsula on the Saudi coast.

The world's largest oil export terminal has borne witness to an increase in activity over the past fortnight, suggesting that the country is ramping up crude production as sanctions disrupt Iranian exports.

According to a report by the Financial Times, the impending increase in output will test the country's production capacity at levels not seen since the late 1970s. While almost all major oil producers pump at full capacity, Saudi Arabia has attempted to preserve at least 1.5 million barrels per day (bbl/d) of spare capacity in order to boost output if needed.

With inventories of crude held by industrialized nations at their lowest level in four years, and the lowest in 15 years in Europe, Saudi Arabia's spare capacity is one of the last remaining buffers in the market.

Saudi Arabia has used its spare capacity several times when shortfalls were evident, including during the US-led invasion of Iraq and last year's collapse of Libyan oil output. However, it seems that doing so may be more challenging this time around.

Amrita Sen, oil analyst at Barclays Capital, said that the starting point is not “nearly as comfortable” as it was last year when Saudi Arabia reacted to a halt in Libyan supply.

Iran is very much the central theme behind current market fundamentals, and is a main indicator of global prices. Markets remain on edge, and until all parties come to an agreement regarding Iran's nuclear programs, speculation and volatility will very much be the order of the day for crude markets moving forward.

Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.